Core Sector Growth Shows a Minor Revival

Core sector growth for the month of July came in at 2.4%, which is a slight improvement over the 0.8% core sector growth shown in the month of June 2017. The core sector is a combination of 8 core infrastructure sectors which form the back bone of the economy and includes coal, crude oil, natural gas, refinery products, fertilizers, steel, cement and electricity. These 8 sectors are also important for two reasons. Firstly, they account for 40.47% of the index of industrial production (IIP) and therefore it is also a very crucial input for overall GDP growth as well as for corporate sale and profitability. Secondly, most of the core sector components have strong externalities. For example coal, crude oil, steel and cement have a high impact on GDP and their marginal impact on GDP is more than 1. This makes the core sector growth specifically meaningful for the economy.

How the core sector growth has trended in the last month?

The monthly core sector numbers are largely a function of the base effect and hence that has to be interpreted accordingly. The chart below capture the monthly trend of core sector growth…

As the chart indicates the monthly numbers have been quite erratic but the underlying trend as captured by the trend line is sloping downwards. This indicates a negative bias in case of core sector growth. However, it needs to be remembered that even in this case the impact of demonetization and GST has been quite pronounced. Sectors like cement and construction took a major hit because of the cash crunch. Similarly, fertilizers sales were also tepid as the agriculture sector was hit by the downstream impact of demonetization. Overall, manufacturing and services also got impacted by the launch of GST effective July which impelled companies to focus more on inventory offloading

rather than on additional production. In fact, economists like Arvind Virmani have also blamed the high levels of real interest in the economy for this phenomenon.

How the components of core sector growth fared?

Coal production for July grew at just about 0.7%, which is disappointing considering the momentum that this sector had in the previous two years. There are too many structural and regulatory hurdles and that has also been partially responsible for the tepid growth in the power generation. For the month of July 2017, crude oil showed a decline of 0.5% while refinery products showed a decline of 2.5%. For refiners, availability of crude and maintenance shutdowns has been responsible for the fall in production. Oil extraction is down due to weak oil prices. Among the other key sectors, cement production was down by 2.5% as there was weak off-take from the construction segment. Ever since the implementation of the RERA, there has been a marked slowdown in real estate activity and that has had a profound impact on cement output. While infrastructure spending is on the rise; it has not exactly provided the alpha.

The major positive contribution came from steel and electricity and natural gas and that is the trend that has sustained for the last few months. Both these sectors, interestingly, are the ones where the government policy has been largely favourable for business. In case of steel, the government has continued to impose anti-dumping duties against China and therefore the Indian steel industry is now actually becoming a net exporter of steel. Natural gas is another sector where the cues have been positive from the government side. The electricity sector has also shown positive trend but it is still at a lower plane compared to last year. In fact, the key driver for growth in electricity production has been the inclusion of renewable sources of energy in the new series.

To be fair, one needs to take a longer term view on core sector…

As we have seen earlier, the monthly numbers for core sector growth have been quite erratic. However, an annualized growth will give a smoother picture as captured below…

The 2.5% core sector growth in the first quarter of 2017-18 does not compare too favourably with the rate of 6% in the corresponding period last year. However, if one looks at the annual rate of core sector growth, then the trend appears to be positive. For the fiscal year 2016-17, the core sector growth has come in closer to the best performance in the last 5 years. It is still not clear how the core sector numbers for fiscal 2017-18 will pan out but a lot would depend on how these 8 sectors adjust to the combined impact of demonetization and the implementation of GST. That trend will be clearer in the next couple of quarters. But more importantly, the Indian economy will have to neutralize the combined impact of demonetization, GST and high real interest rates. That will be a big challenge for the Indian economy!